The violence in Egypt following the military overthrow of former president Mohamed Morsi continues to escalate. Over 800 are dead according to official reports, thousands dead according to other reports.

The stock market, bond market and credit markets have all responded. Credit Default Swaps (CDS) soared to 810, placing Egypt in the top-10 of countries likely to default on sovereign bonds.

Egyptian shares fell the most in two months as Islamists called for more protests following a government crackdown that has left at least 800 people dead. Borrowing costs rose for the first time in seven weeks at an auction today.

The benchmark EGX 30 Index slumped 3.9 percent, the most since June 12, to 5,334.55 at the 1:30 p.m. close in Cairo.

Stocks slid as concerns of an escalation of violence grew following calls by supporters of former Islamist President Mohamed Mursi to continue demonstrations demanding his reinstatement. At least 173 people died in weekend clashes that followed the violent breakup of pro-Mursi protest camps on Aug. 14. The stock market closed Aug. 15 in the first unscheduled shutdown since January 2011, when it suspended trading for almost two months.

Yields Rise

Egypt sold 5.5 billion pounds at an auction of treasury bills today, with the yield on three-month notes rising 18 basis points from last week to 11.44 percent, according to central bank data on Bloomberg. The yield on nine-month bills advanced three basis points to 12.41 percent. Yields on both maturities had plunged 311 and 260 basis points, respectively, since the military deposed Mursi July 3. A 6.5 billion-pound auction, canceled Aug. 15 amid the unrest, will be held tomorrow, according to central bank data on Bloomberg.

Five-year credit default swaps, contracts which insure the country’s debt against default, climbed to 810 basis points, according to CMA data, ranking Egypt among the 10-riskiest credits in the world.

Brussels said it will “urgently review” relations with Egypt following an escalation in violence over the past week that has left EU leaders increasingly worried about the future of peace and stability in the Arab world.

EU officials said that the review was likely to recommend a suspension of various forms of aid and loans in total worth €5bn, which had been earmarked to help Egypt in its transition towards democracy following the popular revolution that ended the military regime of Hosni Mubarak two years ago. Suspension would require the backing of EU member states.

The EU together with its 28 member states in November promised Egypt a total of €5bn in grants and loans for a series of initiatives and projects on the condition that democratic reforms were implemented. There was no timescale for disbursement of the funds.

EU officials said that it was too early to identify exactly which parts of the EU-Egypt relationship would be affected by the review but they added that the blocking of funds was “very much on the table”.

Sens. John McCain (R-AZ) and Lindsey Graham (R-SC) have finally come around to joining Sen. Rand Paul (R-KY) in believing that the U.S. should cut off aid to Egypt amid the deteriorating conditions in that country.

In a joint Friday afternoon statement, McCain and Graham called for the $1.5 billion of annual U.S. aid to Egypt to be cut off until conditions improve there.

“The massacre of civilians this week in Egypt has brought our longstanding relationship with that country to a fork in the road,” McCain and Graham said. “The interim civilian government and security forces – backed up, unfortunately, by the military – are taking Egypt down a dark path, one that the United States cannot and should not travel with them.”

Both Graham and McCain opposed an amendment Paul offered in late July that would have redirected the $1.5 billion per year the U.S. spends on Egypt to help rebuilding the interior of the United States. “All I can see is the billions of American tax dollars that he chooses to send overseas,” Paul said on the Senate floor during that battle, according to Politico. “The president sends billions of dollars to Egypt in the form of advanced fighter planes and tanks while Detroit crumbles.

“In our hour of need in our country, why are you sending money to people that hate us?” Paul added.

When McCain opposed Paul’s amendment cutting off aid to Egypt, he argued that such a move would hurt Israel. “This is a question of whether the senator from Kentucky knows what’s better for Israel, or if Israel knows what’s better for Israel,” McCain said.

Graham made the same argument. “I have a letter here from AIPAC [American Israel Public Affairs Committee] I asked them to comment," Graham said, according to Foreign Policy magazine. Graham then cited the AIPAC letter: “We do not support cutting off all assistance to Egypt at this time.”

Initially we pointed out that the 'new boss was the same as the old one'. He had simply adopted the state's apparatus of coercion for his own purposes. We then pointed out that he had failed in the most important task of his presidency: namely that of improving the economy. It is very difficult to do so, given the vested interests in Egypt. It is for instance estimated, that the army controls roughly 40% of the economy. Thus any reform attempt that may result in reducing the army's influence on economic life is probably doomed from the outset. Our friend Raj reports regularly from Egypt, and he too stated very early on that unless Morsi managed to right the economy, he was going to be doomed.

Let us not forget, it was probably mainly a surge in food prices that ultimately led to the downfall of Mubarak. What Egypt needs more urgently than anything else is free market capitalism.

Following the bloody confrontation between the army and the supporters of Mohammed Morsi – who, it must be pointed out once again, won the election fair and square and was deposed in a coup – one must fear that the chaos will worsen and could eventually morph into a civil war type situation. In that case, we would expect the military to install a junta and attempt to rule the country under emergency regulations.

In the 'Egyptian street' people are convinced that Morsi was only deposed after the US secretly gave its placet to the coup, and very likely this interpretation is correct. After all, the Egyptian military relies heavily on US aid, therefore it probably wouldn't take such a step without first getting the nod from the puppet masters holding the purse strings.

Mubarak's reign has shown that it is in principle possible to oppress the population of Egypt for a long time. The army is no doubt counting on its superior firepower to enable it to do the same thing again. It has already arrested the most important leaders of the Brotherhood, thereby 'decapitating' its main enemy.

The main problem is actually not that the Brotherhood insists on the return of the legitimately elected president Morsi, the main problem is that many people have nothing left to lose due to the miserable economic situation. Moreover, like many other Arab states, Egypt's demographics are such that there is a very large contingent of young people. Young people are by nature less likely to shirk confrontation, they are more hot-headed and less risk-averse than older people. Many are also jobless and see no future for themselves in today's Egypt. It may therefore not be so easy to suppress the revolt and the probability of a civil war breaking out cannot be dismissed out of hand.

Egyptian Pound

Civil War Has Started

It appears to me that a civil war has already started. Regardless, the pertinent question is "How quickly can the military suppress the violence?"

I do not know the answer to that. However, one can watch the stock market, interest rates, credit default swaps, and the Egyptian pound to survey the progress. The currency has stabilized for now, but indicators in aggregate are not so promising. Initially, yields fell following the overthrow of Morsi. Now, along with CDS, they are on the rise.